Economy: Elusive formality spawns collusive informality

LAHORE: We proudly claim that Pakistan has a very open economy, but still in terms of achieving results we are nowhere near other countries that practise as well as promote similar openness.

In Pakistan the economy is officially open for every citizen but in practice openness is only for the elite. The major sectors of economy like sugar, organised dairy, cement manufacturing, textiles, power generation, tourism, and aviation are under the control of a few dozen families.

Most recently almost all the top businesses in the country have started operating state-of-art shopping malls in major cities of the country. These big players are effectively crowding out the entry of newcomers in businesses that they operate. Businessmen with limited resources are afraid of entering fields that are under the control of rich families. This impedes their growth and they prefer to operate informally.

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The invisible cartelised behavior of big businesses has encouraged them to adhere to informality. Almost all the giants are in real estate business. They are also active in capital market and have edged out small commodity hoarders on the strength of their loads and loads of wealth.

Their informal wealth is multiplying exponentially than their formal businesses and because of their huge resources these players act as speculators and manipulators. They operate without any fear as the watchdogs are toothless, regulators spineless, and the governance has run aground. They whiten their informal wealth through engineered remittances. This avenue has been checked this year but real estate and capital market opportunities are still there.

Culturally Pakistani businesses prefer to operate outside the official scrutiny. There are certain firms that are too small to be regulated. Then there are firms that need to operate formally under the law, but they still operate informally.

These two categories belong to lower or lower-middle segment of the society. But there is another category of formal firms that also carry out informal activities separate from their formal operations.

Firms go informal because they see opportunity costs of informality higher than formality. Opportunity costs represent the benefits an individual, investor or business misses out on when choosing one alternative over another.

This is particularly true for formal firms, which, on the sidelines, opt for informal business to earn more. Under-filing of production is also a way to earn more without documenting the production.

Growth in firm size is stunted for some reason in Pakistan due to the same force, which leads to informality. Though the smaller, more informal firms do not demand skills, the firms where skills are important to the output, complain about not having enough skilled hands.

The more formal larger firms are better able to cope and mitigate adverse forces in the investment climate and are also ready to take advantage of upturns and improvements. As in all cases relating to economy, corruption imposes a tax on productivity and competitiveness. The quality of regulation looks good in the book but is practically primitive, the regulatory environment includes many antiquated laws enforced by autonomous and government institutions at federal, provincial, and local levels.

The bureaucratic red-tapism is mainly because of the cumbersome nature of regulations that provide opportunity to the bureaucrats to raise objections. Resolving each objection requires speed money, making it impossible for many formal businesses to operate smoothly and efficiently.

The inspections by the labour inspectors, visits of social security officers, and periodic approvals needed from electricity inspectors, environmental protection agencies cost money. All these regulations can be avoided through bribes.

This brings into question the quality of governance. Operating formally is more costly in many cases than informally. In short, the openness of the economy, the rapid pace of globalisation and the sophistication of firms operating in Pakistan are exposing inadequacies in the regulatory framework. As a result, enforcement brings arbitrary discretion on the part of government officials increasing compliance costs on formal firms.

Enforcement of financial contracts is untested and faces problems at the execution level. Credit bureaus are at a nascent stage of development. Development of secondary instruments and markets to increase the flow of capital from the banking sector are missing.

For instance without clear property rights, lenders will not consider land as a loan collateral without an original sale deed in the bank’s possession. The resulting “dead capital” and lack of site access, hinders leveraged investment, firm level entry, and efficient resource allocation.

The word to the wise is that formalisation of informal economy can help boost revenue generation more than taxing the hand-to-mouth lot of the country out of house and home.

(This news/article originally appeared in The News on November 6th, 2018)